Legal Cases

Richard Marin Scrushy was born 1952 in Selma, Alabama. He is a convicted felon and an American businessman. He is the founder of a global healthcare company HealthSouth Corporation, based in Birmingham, Alabama. Do we all remember that time when Richard Scrushy’s attorneys filed their much-anticipated challenge to Section 906 of the Sarbanes-Oxley Act of 2002? For Corp Law Blog’s carefully managed build-up to this great event, see “Scrushy to SOX: ‘You’re Illegal!'” and “Scrushy to SOX: ‘Parts of You May or May Not Be Illegal, I’m Not Sure Yet’.”

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What does Section 906 address? It is about criminal penalties regarding certifying a misleading or fraudulent financial report. These penalties can be upwards of 5 million American dollars in fines and up to twenty years in prison.

The pages of Corp Law Blog are filled with Scrushy’s exploits. Who can resist a guy who turns a Big 4 auditing firm into certified toilet auditors, who hires big brother Wayne from “The Wonder Years” as a corporate executive, who refuses to leave his company’s board while fighting criminal and civil actions and who oversees the worst special litigation committee ever?

This time he’s serious. And I’m taking him seriously.

Scrushy’s motion to dismiss the Section 906 counts (PDF) carefully dissects Section 906, revealing the many flaws of the statute I’ve previously observed must have been “drafted on the back of a used cocktail napkin.”

Consider the following points made by Scrushy’s lawyers:

SOX makes it a crime not to file a 906 certification, even if the CEO or CFO is unable to determine whether or not the certification is true. This puts the CEO and CFO in a “damned if you do and damned if you don’t” situation.

Section 906 is too vague — terms like “fairly present” and “in all material respects” are too subjective to serve as the basis for criminal liability.

A lot depends on the word “willful,” a word of many meanings none of which are specified in Section 906. An officer whose certification is knowing faces up to $1 million in fines and 10 years behind bars, while an officer whose certification is knowing and willful faces up to $5 million in fines and 20 years behind bars.

Section 906 was drafted in “careless haste” by a Congress that doesn’t, to this day, understand it.

I’m no con law or crim law expert, but I think he’s onto something.

All this reminds me of a penetrating and prescient analysis of Section 906’s perniciousness penned by Sy Lorne only a month after Sarbanes-Oxley passed. So, a former general counsel of the SEC and a former colleague of mine identified three concerns with Section 906’s “extraordinary legislative mandate” that echo throughout Scrushy’s motion:

First, it is not clear who has liability, if anyone, for a failure to observe the obligation.

Written in the passive voice, the statute . . . merely provides that “[e]ach periodic report containing financial statements . . . shall be accompanied by a written statement . . .” to the effect that the report complies with the requirements and contains information that “fairly presents . . . the financial condition and results” of the issuer. Although Section 3(b)(1) of Sarbanes-Oxley provides generally that there are criminal penalties for violations of the statute, it is not clear whether it is the issuer or the executives who are susceptible to being charged.

The second concern a former general counsel of the SEC and a former colleague of mine, identified is:

Due to its curious wording, the only clear basis for “violating” the statutory requirement (which, as a criminal statute, presumably will be strictly construed) is to submit a certificate in a form that does not comply with the statutory requirement. There is no clear provision in the statute that the certificate must be correct, or that one would violate the law by submitting a certificate that, although containing the requisite language, is false. . . .

The third or – what does “right” mean here?

Third, the Section 906 requirement suggests the lack of Congressional (and popular) appreciation for the endless judgments that are necessarily a part of accounting. The popular view is that the numbers should be “right.” But what does “right” mean? A country club has acres of land in the middle of town that were bought a hundred years ago for 10 thousand American dollars and remain on the books at that value. Accounting convention generally forbids writing it up. Is that number right? Do those financial statements “fairly present” the financial position of the club in some abstract sense? Clearly not.

From “Sarbanes-Oxley: The Pernicious Beginnings of Usurpation?” from the Wall Street Lawyer (footnote citations omitted). For more, see “A Challenge to Sarbox Constitutionality” (CFO.com) and Scrushy’s press release announcing the move. Thanks to Broc Romanek for locating the motion and linking to it in his essential blog.